Computing Markov-perfect optimal policies in business-cycle models

Time inconsistency is an essential feature of many policy problems. This paper presents and compares three methods for computing Markov-perfect optimal policies in stochastic nonlinear business cycle models. The methods considered include value function iteration, generalized Euler equations, and parameterized shadow prices. In the context of a business cycle model in which a fiscal authority chooses government spending and income taxation optimally, although lacking the ability to commit, we show that the solutions obtained using value function iteration and generalized Euler equations are somewhat more accurate than that obtained using parameterized shadow prices. Among these three methods, we show that value function iteration can be applied easily, even to environments that include a risk-sensitive fiscal authority and/or inequality constraints on government spending. We show that the risk-sensitive fiscal authority lowers government spending and income taxation, reducing the disincentive to accumulate wealth that households face

Is the elasticity of intertemporal substitution constant?

This paper shows that a power utility specification of preferences over total expenditure (ie. CRRA preferences) implies that intratemporal demands are in the PIGL/PIGLOG class. This class generates (at most) rank two demand systems and we can test the validity of power utility on cross-section data. Further, if we maintain the assumption of power utility, and within period preferences are not homothetic, then the intertemporal preference parameter is identified by the curvature of Engel curves. Under the power utility assumption, neither Euler equation estimation nor structural consumption function estimation is necessary to identify the power parameter. In our empirical work, we use demand data to estimate the power utility parameter and to test the assumption of the power utility representation. We find estimates of the power parameter larger than obtained from Euler equation estimation, but we reject the power specification of within period utility.Elasticity of intertemporal substitution, Euler equation estimation, demand systems

Has the Adoption of Inflation Targeting Represented a Regime Switch? Empirical evidence from Canada, Sweden and the UK

Since 1990, a growing number of countries have adopted inflation targeting (IT) around the world. Empirical evidence on its advantages has been mixed so far, and most assessments have been based on a control group methodology. In this paper, using a MSVAR technique, we assess the adoption of IT in three industrialised countries over time; in addition, we compare their outcomes with a non-IT country, the US. Results are manifold. First, an inflation targeting regime exists, although it does not constitute a change in monetary policy reaction. Second, this conclusion is robust on a subsample excluding the periods of high inflation and early sharp disinflation. Third, the sacrifice ratio of higher output volatility generally attributed to inflation stabilisation policies is not sensitive to the adoption of inflation targeting. Fourth, this framework is shown to be conducive to higher monetary policy leeway.Inflation targeting; MSVAR; Counterfactuals.

the Adoption of Inflation Targeting Represented a Regime Switch? Empirical evidence from Canada, Sweden and the UK.

Since 1990, a growing number of countries have adopted inflation targeting (IT) around the world. Empirical evidence on its advantages has been mixed so far, and most assessments have been based on a control group methodology. In this paper, using a MSVAR technique, we assess the adoption of IT in three industrialised countries over time; in addition, we compare their outcomes with a non-IT country, the US. Results are manifold. First, an inflation targeting regime exists, although it does not constitute a change in monetary policy reaction. Second, this conclusion is robust on a subsample excluding the periods of high inflation and early sharp disinflation. Third, the sacrifice ratio of higher output volatility generally attributed to inflation stabilisation policies is not sensitive to the adoption of inflation targeting. Fourth, this framework is shown to be conducive to higher monetary policy leeway.Inflation targeting;MSVAR;Counterfactuals;

The Natural Rate Hypothesis and Real Determinacy

The uniqueness of bounded local equilibria under interest rate rules is analyzed in a model with sticky information `a la Mankiw and Reis (2002). The main results are tighter bounds on monetary policy than in sticky-price models, irrelevance of the degree of output-gap targeting for determinacy, independence of determinacy regions from parameters outside the interest-rate rule, and equivalence between real determinacy in models satisfying the natural rate hypothesis and nominal determinacy in the associated full-information, flex-price equivalent. The analysis follows from boundedness considerations on the nonautonomous recursion that describe the MA(¥) representation of variables’ reaction to endogenous fluctuations.Nonautonomous difference equations; Indeterminacy; Taylor rule; Sticky information; Sticky prices

Encoding of Marginal Utility across Time in the Human Brain

Marginal utility theory prescribes the relationship between the objective property of the magnitude of rewards and their subjective value. Despite its pervasive influence, however, there is remarkably little direct empirical evidence for such a theory of value, let alone of its neurobiological basis. We show that human preferences in an intertemporal choice task are best described by a model that integrates marginally diminishing utility with temporal discounting. Using functional magnetic resonance imaging, we show that activity in the dorsal striatum encodes both the marginal utility of rewards, over and above that which can be described by their magnitude alone, and the discounting associated with increasing time. In addition, our data show that dorsal striatum may be involved in integrating subjective valuation systems inherent to time and magnitude, thereby providing an overall metric of value used to guide choice behavior. Furthermore, during choice, we show that anterior cingulate activity correlates with the degree of difficulty associated with dissonance between value and time. Our data support an integrative architecture for decision making, revealing the neural representation of distinct subcomponents of value that may contribute to impulsivity and decisiveness